The longer you invest in the stock market, the more familiar you become with a lot of the concepts that are used to define and justify the various investing methods that drive them. A lot of those concepts can be summarized into cute little sound bites that make them easier to remember and work with. One of the first ones I learned more than two decades ago has become a primary reference point for helping me think about the likelihood a stock will move the way I want: “the trend is your friend.”
For bullish traders, this saying means that if you can find a stock that is already going up, it is likely to keep going up – especially if the stock has broken above previous highs. It can also be applied to stocks in downward trend for the same kinds of traders, because downward trends generally act as warning flags for momentum-based, trend-driven investors to stay away, at least for the time being.
All of the logic I just outlined gets turned on its head a bit when you start talking about principles that drive other, longer-term investing methods and approaches. The longer my investing career has lasted, the more I’ve gravitated to value-driven strategies. Being a value investor doesn’t automatically dismiss the idea of using trends, but it is a bit counter-intuitive to some at first, because it doesn’t shy away from stocks in downward trends.
I’ve learned that those same downward trends often provide the basis for many of the best value-based investments I’ve made. That’s because even as the market tends to overprice good news (and positive expectations) into stocks, it also often over-punishes bad news or less-than-rosy expectations. In the negative case, that means downward trends often push stock prices further below the “fair” values the market generally tends to give them. If the company’s core fundamental strength is still in place, the downward trend can simply be attributed to current market action, which also implies the market will eventually recognize the stock’s deeply discounted status as well. Value-driven analysis provides investors like me an opportunity to identify where those opportunities may lie before the rest of the market starts to jump onboard. Even better in my view are the cases where the stock has been following a long-term downward trend, but begins to show strong technical signs of a reversal of that trend to bullish conditions. The early stages of that reversal can be thought of as the “sweet spot” for people like me that try to combine value-driven discipline with technical techniques.
The caveat for any long-term investing method, however, lies in the fundamental data. If the company’s fundamentals are showing deterioration, over time or across multiple metrics, there is a stronger case to make for another common idiom technicians love to quote: “the market is always right.” That’s why using value investing concepts to drive investment decisions can sometimes be challenging.
Westrock Company (WRK) is a stock that followed a downward trend from a 52-week high in May 2021 at around $61.50 last year, but saw the trend bottom in March of this year and pick up enough momentum to suggest a bullish reversal was in place. After hitting a short-term peak at around $54 earlier this month, the stock has dropped back as market conditions have remained volatile, but appears to have found a recent bottom at around $46. Despite increasing input costs that have affected every sector of the economy, WRK is a company that has weathered the storm of the past couple of years better than most. This is a stock that in 2021 offered a very useful value proposition, but the question now is how current conditions have impacted that argument. Is it still as an attractive an opportunity as it has been? Let’s dig in.
Fundamental and Value Profile
WestRock Company, incorporated on March 6, 2015, is a multinational provider of paper and packaging solutions for consumer and corrugated packaging markets. The Company also develops real estate in the Charleston, South Carolina region. The Company’s segments include Corrugated Packaging, Consumer Packaging, and Land and Development. The Corrugated Packaging segment consists of its containerboard mill and corrugated packaging operations, as well as its recycling operations. The Consumer Packaging segment consists of consumer mills, folding carton, beverage, merchandising displays, and partition operations. The Land and Development segment is engaged in the development and sale of real estate primarily in Charleston, South Carolina. WRK has a current market cap of $12.3 billion.
Earnings and Sales Growth: Over the past year, earnings increased 116.7%, while sales rose 21.3%. In the last quarter, earnings were 80% higher, while sales increased by about 8.7%. That positive pattern is contradicted by the company’s operating profile; over the last twelve months, Net Income was 3.93% of Revenues, but weakened to 0.74% in the last quarter. This suggests the company is on the razor’s edge between being profitable and spending more than they are bringing in.
Free Cash Flow: WRK’s Free Cash Flow is healthy, at $1.23 billion, and which translates to a Free Cash Flow Yield of 9.71%. It does mark a decline over the last year, when Free Cash Flow was $1.7 billion, but did increase from $1.02 billion in the quarter prior. This is a counter to the troubling Net Income pattern described above.
Debt to Equity: WRK has a debt/equity ratio of .69, which is pretty conservative. The company’s balance sheet shows limited liquidity, with cash and liquid assets of about $360.2 million in the last quarter versus long-term debt of about $7.9 billion. The company focused for most of 2020 and 2021 on debt reduction, most of which came from the 2018 acquisition of KapStone Packaging. As of the latest report, they have retired enough of that debt to reinstate stock buybacks.
Dividend: WRK pays an annual dividend of $1.00 per share, which at its current price translates to a dividend yield of about 2.08%. After cutting their dividend by 57% in 2020 to preserve cash during the early stages of the pandemic, management increased the dividend by 20% in May of this year and again from $.96 two quarters ago. These are moves that signal management’s increasing confidence in the underlying strength of their business.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target a little above $52 per share. That suggests that WRK is undervalued by about 8% from its current price, with a useful bargain price at around $42. This is a number that declined from August of 2021, when this same analysis yielded a fair value target of $58 per share, but increased from $48 prior to the latest earnings announcement.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the last year of price activity for WRK. The diagonal red line marks the stock’s downward trend from May of 2021, when the stock peaked at around $62, to its March low at around $41. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock staged a short-term upward trend from that March low, hitting a peak at around $54 earlier this month and inline with the 61.8% retracement. Broad market momentum has driven the stock sharply off of that high and below the 50% and 38.2% retracement lines. It appears to have found near-term, current support at around $46, with immediate resistance at around $48.50 where the 38.2% retracement line sits. A push above $48.50 should find next resistance at around $52, a little above the 50% retracement line, while a drop below $46 could see the stock drop to about $43 before finding next support, based on previous pivot activity in that range earlier this year.
Near-term Keys: WRK’s rally into the start of this month looked like an encouraging start to a long-term trend reversal. The stock’s drop from that point doesn’t invalidate the new upward trend, but it may redraw and moderate the slope of that trend if the stock’s current support bounce holds up. The company’s fundamentals are generally solid, but have enough variability – characterized by the decline in Net Income – that I it’s hard to call WRK a useful value-focused opportunity right now. I think the smart thing is to wait and see if the stock’s current support holds, breaks down, or reverses, and to keep a close watch on the next couple of quarters of financial results. If you prefer to focus on short-term strategies, the current bounce off of $46 could be a signal to think about buying the stock or working with call options, with a quick profit target at the top of the stock’s current consolidation range at $48.50. A drop below $46 could be a useful signal to consider shorting the stock or buying put options, with $43 providing a practical exit target for a bearish trade.